The invention relates generally to methods for managing investment portfolio and more particularly to a method based on multiple share combinations and interrelated share variation price for optimizing the return of an investment portfolio.
The behavior of the stock market, of a group of shares or of an individual share, has proven to be random, dependant, unpredictable, irrational and risky:
a) Almost random: chance predominates, professional analysis only rarely produces better results than coin flipping.
b) Sometimes dependant: stocks' performances are not always independent of each other, when one goes up in response to some news, the others' chances of going up or down may be affected and this in turn affects their joint volatility (see John Allen Paulos, “A Mathematician Plays the Market”, Allen Lane, The Penguin Press, 2003).
c) Often unpredictable: even the owner of a company cannot be sure about what is going to happen tomorrow with his company and its share price, how could external people know, be it experts or analysts? Indications like past earnings are no help in predicting future growth.
d) Occasionally irrational: every stock can only be worth the value of the cash flow it is able to earn for the benefit of investors (see Burton G. Malkiel, “A Random Walk down Wall Street”, W.W. Norton & Company Inc, 2003). But stock prices fluctuate more than the long term fundamentals of a corporation, they clearly overreact temporarily to market, forces, news and noise (see John Y. Campbell & Robert J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook” paper written in July 1997, based on the authors' testimony before the Board of Governors of the Federal Reserve System Dec. 3, 1996).
e) Always risky: the higher the return, the higher the risk, and high risk means that the return may not materialize or may even turn into a loss (see Paul Jorlon, “Investing in a Post-Enron World”, McGraw Hill, 2003).
To beat the market, different categories of investors are using quite opposite strategies:
fundamentalists versus chartists
sell winner buy loser versus buy winner sell looser
long term buy and hold versus instant trade
but neither theory seems to be right or wrong and, due to randomness, today's winners are tomorrow losers and vice versa.
The records of all categories of professional investors have been studied and, as indicated by Malkiel, no sizeable differences in performance of common stock portfolios exist, nor has their performance as a group been any better than of a broad-based market index.
simply picking and holding stocks and investing in a broad market index is a strategy that is hard to beat. Unless the investor or the professional portfolio manager disposes of a system that consistently acts within a chosen strategy and according a chosen pattern, while neutralizing the effect of randomness, dependency, unpredictability, irrationality and riskiness.
Some strategies have tried to detect joint volatility between stocks and use such correlation to improve performance. If a few were able to generate sufficient excess return over a given period of time, like pair trading (see Evan G. Gatev, William N. Goetzmann and K. Geert Rouwenhorst, “Pairs Trading: performance of a relative value arbitrage rule”, Yale School of Management, draft Feb. 27, 1999), all depended on finding closely negatively correlated pairs of shares. Again, as this is based on historical price evolutions, the use of it for future decision taking eventually turns out to be useless.